Iceland Risks Bankruptcy, Leader Says

By

Charles Forelle

Updated Oct. 7, 2008 12:01 am ET

REYKJAV&Iacute;K, Iceland -- Saying Iceland was at risk of "national bankruptcy," Prime Minister Geir Haarde prepared to give regulators authority to take over the nation's ailing banks as a worsening financial crisis all but cut off the island from the global financial system.

Credit lines to Iceland's banks closed down Monday, Mr. Haarde said in a televised address. Late Monday, Iceland's parliament was voting on an emergency law that could put the entire banking system under government control. It was expected to pass.

"There is a very real danger, fellow citizens, that the Icelandic economy, in the worst case, could be sucked with the banks into the whirlpool and the result could be national bankruptcy," Mr. Haarde said. After the speech, Standard & Poors cut Iceland's foreign-currency sovereign-debt rating for a second time in a week.

"The banking system is not functioning," said Paul Biszko, an analyst at RBC Capital Markets in Toronto. "Everybody's cutting them off."

In theory, putting the banks under the government's wing and downsizing them should encourage others to lend to them. But that's far from assured, and Iceland is still likely to need capital to save its banking system, analysts say, given the economy's small size.

Mr. Haarde said Iceland was in touch with other countries in a hunt for outside sources of liquidity. Those efforts didn't yield any fruit. "It's turning out that it is every man for himself, every country for itself," he said.

In years of easy credit, Iceland's banks swelled. They lent at home and abroad. Their assets rose to 10 times the economic output of the nation of 300,000. Then the credit crunch sapped access to funding, leaving them vulnerable to fears their small country couldn't stand behind them if trouble struck.

The government's task is to ensure a less-ambitious banking system that is sufficient to "serve the Icelandic people and Icelandic industry," said &Oacute;lafur &Iacute;sleifsson, an economist at Reykjav&iacute;k University.

Under the bill in Parliament, the government has wide-ranging authority to take over banks, seize control of management and direct asset sales. Mr. Haarde wouldn't say whether the government would use the full powers but said "it is conceivable that some [banks] will not be able to function without the authorities intervening."

One of Iceland's three big banks,
Glitnir Bank
hf, was effectively nationalized last week, when the government put in &euro;600 million ($810 million) for a 75% stake. Ratings agencies quickly cut Iceland's sovereign-debt ratings, and the cost of insuring the debt against default jumped.

Some analysts believed nationalization of the remaining big banks is now likely. A spokesman for Kaupthing Bank hf, Iceland's biggest, said Kaupthing was getting support from Iceland's central bank but "will not be nationalized." A spokesman for a third large bank, Landsbanki &Iacute;slands hf, declined to comment.

If banks dump their foreign assets, that should also boost the wilting Icelandic krona. The currency is off more than 40% against the euro this year, an example of how badly the banking crisis is bleeding into the broader economy. The devalued currency has set the stage for further inflation -- the rate stood recently at 14% -- on the import-dependent island.

The increases in cost of living and in household-debt servicing, as many car and home loans are linked to inflation, have crimped lifestyles in a country that had become accustomed to credit-fed consumption.

Meantime, the International Monetary Fund sent a fact-finding team to Iceland, an IMF spokesman said Monday.

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Iceland Risks Bankruptcy, Leader Says

REYKJAV&amp;Iacute;K, Iceland -- Saying Iceland was at risk of &quot;national bankruptcy,&quot; Prime Minister Geir Haarde prepared to give regulators authority to take over the nation's ailing banks as a worsening financial crisis all but cut off the island from the global financial system.